KAZAKHSTAN: PROPOSED TAX CODE CHANGES COULD IMPACT OIL

UNCLAS SECTION 01 OF 02 ASTANA 002226

SENSITIVE
SIPDIS

STATE FOR SCA/CEN, EEB/ESC
STATE PLEASE PASS TO USTDA DAN STEIN

E.O. 12958: N/A
TAGS: PGOV EPET EINV KZ
SUBJECT: KAZAKHSTAN: PROPOSED TAX CODE CHANGES COULD IMPACT OIL
AND GAS SECTOR

REF: ASTANA 01910

ASTANA 00002226 001.2 OF 002



1. (U) Sensitive but unclassified. Not for public Internet.


2. (SBU) SUMMARY: In September, the Ministry of Finance submitted
several proposed changes to the tax code to Parliament. If
Parliament adopts the amendments, the changes will take effect
January 1, 2009. A major objective of the new tax code is to
increase tax revenues from the extractive industries. The new tax
code would lower corporate income taxes, the crude oil rent tax, and
the value added tax, while introducing new taxes for mineral
extraction and excess profits. Business associations and investment
advisors are concerned that the new tax code will undermine tax
stability clauses in existing and future contracts. The government
has said it will guarantee tax stability only for Tengizchevroil
(TCO),which has a tax and royalty contract, and for existing
production sharing agreements (PSAs),if the contracts are ratified
by legislative acts of the Kazakhstani parliament. END SUMMARY.


3. (U) According to Tomas Balco, Senior Manager for
PricewaterhouseCoopers, the government's stated objectives for
amending the tax code include:

- reducing the tax burden for non-oil and gas industries;
- supporting economic diversification;
- curtailing the shadow economy;
- optimizing tax incentives;
- improving recovery of value-added tax (VAT) refunds; and
- increasing tax revenues from the extractive industries.

LOWER TAXES FOR CORPORATE INCOME, RENT, AND VALUE ADDED


4. (U) The new tax code would lower corporate income tax rates to
15% over a period of three years (to 20% in 2009, 17.5% in 2010, and
15% in 2011). The maximum rent tax on exported crude oil and gas
condensate would be lowered to 32% (down from 33%) and this maximum
rate would only apply if the price of oil is greater than $200 per
barrel. Furthermore, companies subject to both the crude export
customs duty and the rent tax would receive a tax credit so as to
avoid double taxation. The VAT would decrease to 12% and geological
exploration and prospecting operations would no longer be exempt.

NEW CORPORATE TAXES INTRODUCED


5. (U) A new mineral extraction tax would replace royalty payments
in oil and gas contracts. Under the new tax code, the government
will assess oil and gas condensate production at 7% to 20%,
depending on annual volumes. The tax rate will be 50% lower for
domestic sales of crude oil and gas condensate. The mineral
extraction tax for natural gas will range from 0.5% to 1.5% and for
minerals from 0.3% to 17%. The tax base for the mineral extraction
tax will be the average world price of the relevant natural resource
for the reporting quarter.


6. (U) The proposed new excess profits tax would likely hit
extractive industries hardest. Companies with profits greater than
25% would have to pay an excess profits tax based on a progressive
sliding scale, with a maximum tax rate of 60% applied to profits
exceeding 70%.

CHANGES TO TAX STABILITY MAY AFFECT INVESTMENT CLIMATE


7. (SBU) The new draft tax code would supersede tax stability
clauses for all contracts except Tengizchevroil's tax and royalty
contract (TCO) and existing PSAs, provided those contracts are
ratified by legislative acts of the Kazakhstani parliament. Almas
Zhaiylgan, a lawyer in Almaty with the firm DentonWildeSapte, was
skeptical that many investors would benefit from the government's
guarantee. According to Zhaiylgan, "It is unclear why Parliament

ASTANA 00002226 002.2 OF 002


must pass a separate law approving government contracts. This
appears to be an attempt to eliminate tax stabilization for all but
those very few contracts ratified by Parliament."


8. (SBU) PricewaterhouseCoopers' Balco, a lawyer and chartered
accountant, said, "The proposed changes to tax stability are of
great concern to the established investor community, both foreign
and domestic, since this would be a significant policy change by the
Government of Kazakhstan. The question is, will the Government
honor its commitments or will it sacrifice tax stability and rattle
investor confidence in order to meet short-term financial goals?"


9. (SBU) COMMENT. It is often necessary and even wise for a
government to revise and update its tax code from time to time; that
alone is no cause for concern to companies doing business in
Kazakhstan. Indeed, the new tax code would actually lower many
taxes, such as the corporate income tax, and rationalize several
others. The real issue for investors -- here as elsewhere -- is the
stability and predictability of the tax regime. Should the
government take steps to undermine or challenge the tax stability
clauses in TCO's contract or the Kashagan PSA, as it has done by
imposing Kazakhstan's new crude export duty on the Karachaganak PSA,
that would raise serious concerns. That said, Prime Minister
Masimov has repeatedly reassured us that the government will respect
contract sanctity. He has told us that he has personally advised
the international oil companies to have their contracts ratified by
parliament to provide legal certitude that their tax stabilization
clauses will remain in effect and not be impacted by the new tax
code. END COMMENT.

HOAGLAND